L Bond

An L bond is an alternative investment vehicle that attempts to provide a high yield for a lender in exchange for bearing the risk that an insurance policy premium or benefits may not be paid. An L bond is an unrated life insurance bond that is used to finance the purchase and premium payments of life insurance settlement contracts purchased in the secondary market.

Life insurance bought from an insurance provider is intended to protect the policyholder’s beneficiaries in the event of the policyholder’s death. An insured party with a life insurance contract can also sell the policy in the insurance secondary market if s/he needs cash now, can’t afford the premium payments, or no longer needs life coverage. The investor who purchases the life insurance policy becomes the beneficiary after the transaction is settled. The buyer is responsible for making the premium payments to the insurance company, and when the original policyholder dies, the buyer receives the payout from the insurer.

Life settlement investors buy life insurance policies for more than their surrender value but less than the death benefit of the policies, a strategy known as viatical settlement. These investors aim to make a profit by aligning their expected returns with the life expectancy of the seller. If the seller dies before the expected period, the investor makes a higher return since s/he won’t have to make premium payments anymore. However, if the seller lives longer than expected, the investor earns a lower return. Most investors that invest in these life insurance assets are institutional investors.

Investors that purchase life insurance policies sometimes finance the initial purchases and corresponding premium payments with bonds. Companies issue bonds to secure money to conduct a number of projects. Lenders who purchase bonds are normally paid a coupon rate semi-annually or annually for the duration of the bond’s life. At maturity, the face value of the bond is paid out to the bondholder by the issuing company. In terms of life insurance settlement transactions, the money raised from issuing the bond is used to make the required premium payments to the seller of the life insurance policy. A type of life insurance bond increasingly becoming popular in the financial industry is the L bond.

The L bond is a specialty high-yield bond currently issued by GWG Holdings, based in Minnesota. The company purchases life insurance contracts from seniors in the life insurance settlement market in order to create wealth. In a viatical settlement for example, the company could purchase a $1 million life insurance policy with premium payments of $30,000 a year for $250,000. The funds raised from the L bond are used to purchase and finance additional life insurance assets. When the seller dies, the insurance company pays GWG $1 million. As of 2016, the firm’s portfolio had over 500 policies with a total asset value of $1.15 billion.

The most recent L bond issue of $1 billion was newly offered to the public in 2015 with different maturity terms of 6 months, 1 year, 2 years, 3 years, 5 years, and 7 years. In September 2016, GWG closed its sale of its short-term 6-mth and 1-year bonds and chose instead to focus on its long-term offerings. The interest rates are 5.50%, 6.25%, 7.50%, and 8.50% for its 2-,3-, 5-, and 7-year bonds respectively. Other characteristics of the bond include:

• The bonds are sold in denominations of $1,000 and the minimum investment value for any one investor is $25,000.
• The bonds can be purchased either directly from GWG Holdings or a Depository Trust Company (DTC) participant.
• An L bondholder has the same interest rate for the entirety of the bond term. If GWG changes its interest rate for the bond, the investor would have the new rate applied to his bond if s/he chooses to renew the bond upon maturity.
• When the L bond matures, the bond is automatically renewed to a similar offering unless the bond is elected to be redeemed by the investor or the issuer.
• The bonds are callable. The firm reserves the right to call and redeem any or all of the L bonds at any time without penalty.
• Bondholders cannot redeem the bond prior to maturity unless in the event of death, insolvency, or disability. For reasons other than the dire circumstances mentioned above, if GWG agrees to redeem a bond, a 6% penalty fee will be applied and subtracted from the amount redeemed.

As with all other investments, caution should be taken when considering an investment in L bonds especially as the bonds are a high-risk investment. Their illiquid characteristic means that if the bond is performing poorly, the bondholder has to hold on to it until maturity or pay a 6% redemption fee if applicable. Also, the interest payments on the bonds are linked to the payout if the life insurance policies purchased in the secondary market. If the insured party lives past his/her life expectancy or the insurance company that holds the policy becomes bankrupt, the value of GWG’s portfolio may drop. This could lead to a situation where the firm may be unable to make its interest payments to its L bondholders.